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1: The Nature, Functions, and Classifications of Banking Institutions

The term "bank" is rather indiscriminately applied to a number of financial institutions whose operations differ considerably. The only characteristic they share in common is that they deal with money: its storage and/or the management of ownership of money and financial assets on behalf of their clients.

Service to Clients

In the broadest sense, there are four services of banks: they store money and other valuables, they process payments or transfers of money, they arrange and administer borrowing, and they arrange investment.

Historically, few people handled their own money, and those who did often carried it immediately to retail stores to be spent. It is only in the past few centuries that people of all classes have more money than they need for their immediate survival needs, and have seen the value of storing it in a bank rather than keeping it in a personal vault. The latter is still practiced, but it is on the wane.

The use of banks for processing payments is a natural consequence of having them manage its storage. When one party pays another, he must go to his bank, withdraw the money, and hand it to the recipient - who must then carry the money to his own bank and deposit it in his own account. The inefficiency of this practice is obvious when the two parties keep their money in the same bank: the money need not be moved, merely reassigned from payer to recipient.

The practice of lending has also been greatly facilitated by bankers, who save the depositor the trouble of finding a borrower and collecting payments and who save borrowers the trouble of seeking out a source of funds. All manner of loans may be made among a group of individuals without their needing to meet or negotiate with one another when a banker serves as their intermediary.

Finally, there is the service of investment, which bankers perform on behalf of their depositors as a matter of convenience. The depositor who wishes to invest need not withdraw his money and bargain on the financial market, but allow a representative of the bank to manage his investing.

None of these services are the exclusive domain of the bank, and an individual may deal with four separate companies for these four separate services if he so desires - but the consolidation of these services is convenient and efficient for the banking customer.

Supporting the Community

In serving their individual clients, banks are providing a service that has more widespread benefits for the community. The town or nation in which banks exist have an infrastructure in place to support and facilitate economic activity. That a single person may obtain a loan to purchase a house is a boon to the construction industry, that he may obtain a loan to start a business is a benefit to those he serves and those he employs, that depositors may place his funds in a bank saves each house the expense of a vault and guards.

Banks also function to manage the money supply of a community. Because a bank has access to coin, people can use money to buy and sell, rather than engaging in the inefficient process of bartering good-for-good.

By their interconnection with banks in other locations, a bank can bring the capital of remote investors to the aid of entrepreneurs in the local community as well as enabling local investors to profit from the work of entrepreneurs in remote locations.

The bank also serves as the gateway between the members of the local community and the greater world of finance that exists in the nation and the world at large.

Types of Banking Institutions

There are a number of ways in which banks may be classified.

Those that facilitate the storage and exchange of money are commercial banks; those that specialize in investment are called investment banks. Banks may be specialized in the kinds of services they offer. There are savings banks, mortgage banks, and bond houses, among other kinds. However, few banks strictly confine themselves to a single line of business: they provide whatever services their community needs in sufficient quantity for it to be profitable to serve.

The bank, like any other business, may be a proprietorship, a partnership, or a corporation. It is rare that an individual has sufficient wealth to be the sole proprietor of a bank, and only slightly less rate that a few individuals have the means when their capital is pooled. In most instances, banks are incorporated - in some instances they are owned by their depositors, in others by shareholders who are not clients of the bank.

Certain banks may be founded by political entities - a state or a nation may found its own bank to maintain the funds of the government. Depending on the country, it may be necessary for an individual or group to seek license from their government to establish a bank. The degree to which government interferes with the operation of a bank likewise differs from place to place.

There is also the mention of wholesale banks, or "bankers banks" where banks borrow and lend among themselves to address the surplus of capital or demand of credit in different locations. A bank in a developing county that has more demands to borrow than deposits can obtain capital from a bank in a more established county where wealth is great but growth has cooled.

At the time the book was written, there was no central bank in the United States. In general, banks in large towns would be the mediators between banks in small surrounding towns, the large-town banks would be mediated by one or more banks in a state or regional financial capital (the wealthiest city, which is not necessarily the political capital). Ultimately, a small group of banks in New York city functioned as the hub of the national banking system, which was not formally organized.